Levels of Voluntary Disclosure in IPO Prospectuses

Review of Accounting and Finance
Levels of voluntary disclosure in IPO prospectuses: an empirical analysis

Anne Cazavan‐Jeny, Thomas Jeanjean,
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Levels of voluntary disclosure in Disclosure in

IPO
IPO prospectuses: an empirical prospectuses
analysis
Anne Cazavan-Jeny 131
ESSEC Business School, Accounting and Management Control Department,
Cergy-Pontoise, France, and
Thomas Jeanjean
HEC School of Management, Accounting and Management Control
Department, Jouy-En-Josas, France
Abstract
Purpose – This paper aim to focus on how forecasts information is disclosed in IPO prospectuses. In
France, managers report either detailed forecasts or only a brief summary.
Design/methodology/approach – The authors investigate the determinants and consequences of
the varying levels of details provided in these forecasts. The research is based on a sample of 82 IPOs
on the Euronext Paris market (2000-2002).
Findings – The paper shows that only two variables are associated with highly detailed forecast
disclosures: forecast horizon and firm age. It is also found that the forecast error decreases as the
level of detail in the forecast disclosures increases. This finding is robust to a reverse causality test
(Heckman two-stage self-selection procedure) and suggests that the level of detail in forecast
disclosures enhances the reliability of earnings forecasts.
Research limitations/implications – The paper suffers from at least two potential flaws. First,
omitted variables, such as the possession of good news or proprietary costs. can influence both
forecast errors and the level of detail of forecasts. Second, the negative association between the level
of detail in forecast information and forecast errors may either show that detailed information leads
to less forecast error or reflect a self-selection bias.
Practical implications – This research could have implications for stock market regulators as it
suggests that mandatory disclosure of highly detailed forecasts would improve the effeciency of the
markets by reducing forecast error.
Originality/value – This paper contributes to be literature by presenting evidence tha the way
forecast information is disclosed in IPO prospectuses is of importance and by documenting a
negative association between forecast error and the level of detail in forecast disclosures.
Keywords Disclosure, Reports, France, Financial reporting
Paper type Research paper
1. Introduction
Significant information asymmetry between the issuing firm’s management and
potential shareholders is a characteristic feature of initial public offerings (IPOs). On
one side of the divide, managers have private information on the future performance of
The authors would like to thank Cédric Lesage and workshop participants at the 2005 EAA
Annual Meeting (Göteborg, Sweden), 2005 AFC annual congress (Lille, France), ESSEC
Business School CAP workshop and International Research Conference for Accounting
Educators, IAAER (Bordeaux, France) for helpful comments. The authors are particularly
grateful to the three anonymous reviewers for their insightful suggestions. T. Jeanjean
Review of Accounting and Finance
acknowledges the financial support of HEC School of Management. T. Jeanjean is member of Vol. 6 No. 2, 2007
the GREGHEC, CNRS Unit. A. Cazavan-Jeny acknowledges the financial support of the pp. 131-149
# Emerald Group Publishing Limited
ESSEC Business School Research Center. We are also grateful to Ann Gallon for editing and 1475-7702
to Julien Margaine for research assistance. DOI 10.1108/14757700710750810
RAF the firm. On the other, potential investors have access to little or no information on the
firm, since pre-flotation disclosure requirements are limited. To attenuate this
6,2 asymmetry, management can make disclosures of information in the IPO prospectuses.
Disclosures may be allowed, required or forbidden depending on the national laws. In
the USA, for instance, an IPO prospectus cannot contain any forecast figures, in order
to protect the firm against any lawsuits on the grounds it has failed to live up to
expectations (Clarkson et al., 1991). The inclusion of forecast disclosures in IPO
132 prospectuses is an interesting feature of the French market.
This French specificity (shared with Australia, New Zealand, and Hong Kong)
makes it possible to study the determinants and effects of forecast disclosures in a high
information asymmetry environment where earnings forecasts are particularly
important for shareholders: IPOs. France’s financial regulator, the AMF (Autorité des
Marchés Financiers – Financial Market Authority) requires firms undertaking IPOs on
the Nouveau Marché to produce forecast financial statements over a three-year
timeframe. But there are no such requirements for firms that choose the Second marché
for their IPO. Since the Second marché attracts mainly relatively large and well-known
firms, the information asymmetry between managers and potential investors is less
significant than on the Nouveau marché which is preferred by new firms, mainly from
the high tech sector. However, all firms during the period 2000-2002 undertaking
flotations on the Second marché disclosed financial forecasts.
While all sample firms involved in IPOs on both the Nouveau marché and the
Second marché disclosed forecasts, there is considerable variance in the way
information is disclosed. Managers can provide private information in many ways:
their forecasts can be very detailed, presenting a full set of financial statements and a
description of their assumptions. Alternatively, their forecasts can be very brief, simply
a table with key indicators. This point is important because detailed forecasts reduce
the information asymmetry between the management of the firm undertaking the IPO
and its potential investors (Lev, 1992), but has gone largely unstudied because most
developed countries’ regulatory bodies will not allow or do not require firms
undertaking IPOs to publish earnings forecasts. Past research (e.g. Mak, 1996) has
concentrated on the determinants and effects of disclosure vs non-disclosure of
business forecasts. In this study, because all the firms in our sample disclosed financial
forecasts, we focus not on forecast disclosures vs non-forecast disclosures, but on how
forecast information is disclosed.
The main purpose of this study is to examine the determinants and consequences of
the level of detail in forecast disclosures published at the time of IPOs. The study
comprises two stages. Our first aim is to understand the determinants of the level of
detail in the forecast disclosures. The second is to examine the influence of the level of
detail in forecast financial statements on forecast error. Without exception, French
firms publish earnings forecasts for the post-IPO years in their prospectus. The aim is
to determine whether the forecast error, i.e. the difference between actual reported
earnings and the expected earnings, is affected by the level of detail in the forecast
financial statements. And since the publication of forecasts involves disclosure of
earnings forecasts, it will also be useful to analyse the impact of the detail level on
future earnings forecast errors. Previous research has shown that firms underperform
in the long term following their initial flotation on the stock market (Degeorge and
Derrien, 2001). This underperformance can be attributed to over-optimism on the part
of investors regarding future earnings. The identification of factors that encourage
management to publish reliable earnings forecasts is thus valuable, because it
contributes to market efficiency by curbing one of the sources of underperformance in Disclosure in
respect of shares issued following IPOs. IPO
Our study differs from previous literature on earnings forecast disclosure in several
respects. First, prior research has generally focused on forecasts disclosed by already- prospectuses
listed firms (e.g. Imhoff, 1978; Waymire, 1984; Pownall and Waymire, 1989; Ruland
et al., 1990), while we focus on earnings forecast disclosure by IPO firms in their
prospectuses. There is little empirical evidence on the factors associated with the 133
disclosure of earnings forecast information in an IPO context, except Mak (1996).
Second, previous studies on earnings forecast disclosure have mainly been carried out
in the USA (e.g. Jaggi and Grier, 1980; Ruland et al., 1990), where disclosure costs are
high (Clarkson and Simunic, 1994, p. 211). In that type of environment, forecast
disclosure may be significantly affected by supply-side cost factors. This study instead
examines forecast disclosure in France, where disclosure costs are likely to be lower,
and accordingly forecast disclosure may be driven more strongly by the benefits it
brings. Third, while previous research has tended to distinguish between forecasting
and non-forecasting firms (e.g. Jaggi and Grier, 1980; Ruland et al., 1990), this study
distinguishes between different levels of detail in disclosure of earnings forecasts.
Our research also differs from previous studies on earnings forecast disclosure at
the time of IPOs. To the best of our knowledge, only Mak (1996) has examined the
determinants of forecast disclosure by IPO firms. However, our study differs from Mak
(1996) on two important points. First, we examine the level of detail of forecast
information rather than the disclosure or non-disclosure of forecast information. In
other words, we examine the frame used by managers to disclose business forecasts
(Do they use prospective balance sheets? Do they present an assumption section? etc.)
rather than the disclosure or otherwise of earnings forecasts. Second, we also
investigate the relationship between the level of detail in forecast disclosures and the
reliability of earnings forecasts, which is not the case in Mak (1996). There is extensive
literature on the determinants of management forecast errors at the time of IPOs
(Brown et al., 2000; Cheng and Firth, 2000; Jelic et al., 1998 among others). Prior papers
have concentrated either on the determinants of management forecast accuracy ( Jelic
et al., 1998) or the forecaster/non-forecaster dichotomy and its relationship to future
performance (Jaggi and Grier, 1980). However, no existing study has investigated the
association between the level of forecast disclosure and earnings forecast error.
We study a sample of 82 IPOs on the Euronext[1] Paris market in 2000, 2001,
and 2002. We first construct a measure for the level of detail in forecast information.
We find that two patterns exist in forecast disclosure: either firms choose to publish
very detailed forecast information (‘‘detailed forecasts’’), or they just present a
summary table (‘‘basic estimates’’). We first tried to explore the determinants of this
level of detail. Our theoretical framework derives from agency and signalling
theories. Results show that the only significant determinants are: the forecast
horizon and the firm age. We then analyse the relation between forecast error and
the level of detail in forecast disclosures. Our prediction is that the forecast error
should decrease with the level of detail in forecast disclosures. This hypothesis is
backed by our empirical data. The negative association between the level of detail
in forecast information and forecast errors may either be evidence that detailed
information leads to less forecast error, or alternatively it may indicate the existence
of a selection bias: only firms with reliable forecasts disclose detailed forecasts.
To discriminate between these two interpretations, we run a Heckman two-stage
RAF self-selection procedure. Empirical findings suggest that the selection bias is not
significant.
6,2 The remainder of this paper is organized as follows. In section 2, we present some
relevant institutional background on IPOs in France. Section 3 develops our research
hypotheses. In section 4, we discuss our methodology and our sample selection. Section
5 presents our empirical results, and section 6 discusses the results and presents
research implications.
134
2. Forecast disclosures and IPOs in France
The first subsection describes the French IPO environment. Subsection 2 presents the
financial disclosures required in IPO prospectuses.
Definition of IPOs
Flotation on the stock market through an IPO is a major decision for a firm. Its main
advantages for the firm are that it provides access to capital markets, makes the firm’s
value public and makes its name more widely known. For the shareholder, too,
especially the minority shareholder, the stock market, with its mandatory disclosures
and equitable treatment requirements when majority stakes are sold, plus the incentive
it provides for a coherent dividend policy, offers a degree of liquidity and protection
that can never be had from any shareholder pact. But an IPO brings with it a certain
number of constraints for the firm. Apart from the cost of information, which can be
significant, it means the firm’s strategy will be more dependent on financial
parameters (such as PER, earnings per share, etc.).
French firms can choose one of three stock markets for their IPO (Premier marché –
the main market, Second marché – midcap market, Nouveau marché – for high-tech,
high-growth stocks). We did not include premier marché IPOs as the firms concerned
were too different from firms launching IPOs on the other markets. Since IPOs on the
Premier marché concern either much larger firms than those floating on the Second
marché and Nouveau marché, or partial privatisations of nationalised firms, the firms
involved are not comparable with our sample firms. The requirements for IPOs depend
on the relevant market (see Table I), and concern features of the firm itself (size, age) as
well as criteria related to the value of the issue or the level of information to be
provided before and after the operation.
The financial intermediary handling the IPO must send out a prospectus containing
information on the main features of the issue (number of shares offered, value of the
firm, and procedure) and the firm (its market, its strategy, its ownership structure, and
financial information) approximately one month before the date set for the IPO. The
information required varies with the market (see Table I). Firms that choose the Second
marché, generally assumed to be longer-established than those floating on the Nouveau
marché, must supply more historical data, while their Nouveau marché counterparts
will be required to report earnings forecasts.
Forecast disclosures in IPO prospectuses

The Nouveau marché and Second marché impose different requirements for forecast
disclosures. The Nouveau marché was set up in 1996 to cater for young, fast-growing
firms. The French stock market authorities require prospectuses for IPOs on this
market to contain a section on the firm’s investment policy, ‘‘in principle accompanied
by figures giving a simplified presentation of the firm over three years, possibly
expressed as a range, describing the major balance sheet items, main income statement
Market Second marché Nouveau marché Disclosure in
IPO
Company profile Medium-sized High growth potential prospectuses
international international firms
firms
Criteria concerning the issue: 10 per cent of shareholders’ 20 per cent of shareholders’ equity,
percentage of equity, value, equity, 5 million minimum of 10,000 shares,
number of shares 5 million, capital increase 135
of 50 per cent of the funds
raised by the IPO
Criteria concerning financial Market capitalization: Shareholders’ equity:
indicators 30 million, three years 1.5 million
old, auditor-certified
financial statements
Mandatory . . . past Three last consolidated Consolidated financial
disclosures performance financial statements statements if available, last
in the IPO’s under French rules, three certified financial

prospectus IFRS or US GAAP statements, last positive
concerning . . . plus reconciliation income statement
to French standards
. . . forecast No compulsory three years of forecast
information disclosures statements
Mandatory disclosures after Quarterly sales, As Second Marché+market
the flotation half-yearly progress maker’s analytical report
report, annual report over three years, quarterly
income and cash-flow
statements
Table I.
Source: Euronext web site IPO criteria
items and cash flow statement’’[2]. This requirement is rather vague, prescribing no
precise framework for the ‘‘simplified presentation of the firm’’ or the format of
financial statements, and in practice, the content of the information disclosed by firms
undertaking an IPO on the Nouveau marché varies very widely. Some firms present a
forecast income statement, balance sheet and cash flow statement for the next three
years or more, first describing the forecasting methods used; others simply publish a
table of key forecast figures (net income, total sales). The level of detail in the forecasts
disclosed varies
The Second marché is in principle designed for mature firms. Until 1996, it was very
unusual for IPO prospectuses on the Second marché to contain forecast disclosures, but
firms are now tending to publish such information voluntarily (Schatt and Roy, 2002).
Indeed, in our sample, almost all firms undertaking IPOs on the Second marché report
forecast figures, even when not obliged by law to do so.
Past literature on voluntary disclosure before IPOs has concentrated on the
relationship between voluntary forecast disclosures and forecast error or market
performance, examining the question of whether voluntary earnings forecasts are
associated with increased market rewards (because of a reduction in information
asymmetry) or lower market rewards (because of the unreliability of forecasts). This
paper takes a different approach. All firms that float on the Nouveau marché or Second
marché disclose earnings forecasts, and we concentrate on the influence of the level of
detail in earnings forecasts (detailed forecasts vs basic estimates). It could be
RAF considered that providing detail in forecast disclosures is effectively a voluntary
disclosure for firms issuing shares on the Nouveau marché or on the Second marché[3].
6,2 In other words, we try to explore the determinants and consequences of the format
used by managers to disclose earnings forecasts. Figure 1 presents the theme of this
paper and the differences between our approach and previous literature in graphic
form.
We now turn to a more detailed discussion of past literature and our hypotheses.
136
3. Literature review and hypotheses
Earnings forecasts published in the prospectuses convey ‘‘insider’’ management
information (Firth, 1998), in that they inform investors, in particular, of how the IPO
could affect the firm’s capacities to generate profit, due to development of new projects
to be financed by the capital raised (Cheng and Firth, 2000). This study comprises two
stages. Our first aim is to understand the determinants of the level of detail in the
forecast disclosures. The second stage examines the influence of the level of detail in
forecast financial statements on forecast error.
Publication of forecasts at the Time of IPOs

Agency and signalling theories can explain publication of voluntary disclosures in
prospectuses. Watts (1977, p. 58), for example, considers that in an unregulated
economy financial statements can be considered to reduce agency costs. He shows
(Watts, 1977, pp. 58-9) that in firms issuing new shares, management are keen to reduce
agency costs by supplying information in the financial statements. But Watts does not
specifically discuss voluntary forecast disclosures.
Ruland et al. (1990, p. 713) show that publication of earnings forecasts can attenuate
adverse selection and moral hazard problems, thus making it easier to attract new
capital. They show that firms increasing their capital with low retained ownership by
pre-IPO shareholders publish more earnings forecasts. The incentive to do so should be
high in France, where litigation risks are low (Djankov et al., 2003; La Porta et al., 2000)
and could be expected to lead to a high level of disclosure.
Previous empirical work (e.g. Penman, 1980; Waymire, 1984; Pownall and Waymire,
1989) has documented that the release of managerial earnings forecasts is associated
with changes in the stock prices of forecasting firms, suggesting that investors regard
these forecasts as credible. Many studies (e.g. Penman, 1980; Clarkson et al., 1991) refer
Figure 1.
Voluntary disclosure
before IPOs
to signalling theory to explain why earnings forecasts are published. They test the Disclosure in
assumption underlying signalling theory, which suggests that firms with good news IPO
are likely to publish their earnings forecasts in order to differentiate themselves from
firms with poor performances. Lev and Penman (1990) show that, on average, firms prospectuses
with good news to report do voluntarily disclose forecasts in order to distinguish
themselves from firms with ‘‘worse news’’. Hughes (1986) studies disclosures as a
signal of the corporate value when there is high information asymmetry between
investors and users regarding share price. In her model, the retained ownership rate
137
(percentage of shares retained by the original shareholders) and disclosures act as
signals of the firm’s value. Investors consider that the information disclosed is credible,
as it is presumed that ‘‘the entrepreneur is penalized if the ex post costlessly observable
cash-flow of the firm indicates that the disclosure was fraudulent’’ (Hughes, 1986). All
of these studies show that because of information asymmetry, owner-managers have
an incentive to signal the firm’s value, particularly through earnings forecasts, to
differentiate their IPO from those of lower quality firms.

These studies essentially examine what motivates firms to include profit forecasts
in their IPO prospectuses (e.g. the desire to minimise agency and signalling costs). Mak
(1996) extends the IPO research field by studying the determinants of forecast
disclosures (not restricted to earnings forecasts) in IPO prospectuses. He tests the links
between the level of forecast information (as measured by the number of years covered
by the forecasts) and usual dependent variables (firm age, specific risk, etc.). His study
concerns New Zealand, an environment with low legal risks, and shows that the
greater the information asymmetry and/or the specific risk, the more forecasts are
disclosed. The level of information is also negatively related to the rate of retained
ownership. Our study takes a different perspective, as we focus on the level of detail in
the forecasts disclosed. Agency and signalling theories and prior empirical evidence on
the determinants of forecast disclosure during IPOs enable us to develop our
hypotheses.
In order to test possible determinants of the level of detail in forecast disclosures
for IPOs, five hypotheses are constructed with respect to the following
potential determinants: forecast horizon, firm age, auditors’ reputation, amount of
capital increase and proportion of shares retained by the owners. We also introduce a
control variable for firm size. The reasoning underlying our hypotheses is discussed
below.
If the firm undertaking an IPO can supply profit forecasts over a fairly long
timeframe, this is an indication that it knows its market relatively well and is
presumably in a position to provide reliable forecasts. Also, to better justify the choice
of a long timeframe, managers of issuing firms will tend to give more detailed
information, because investors believe that managers will have more difficulty
controlling events that happen later along that horizon (Mak, 1996).
H1a. The longer the forecast horizon is, the more detail the forecasts will contain.
As the oldest firms have more control over their market, they are in a better position to
provide reliable forecasts (Degeorge and Derrien, 2001). According to signalling theory,
this will generally lead them to supply more detailed forecasts in order to differentiate
themselves from other firms entering the stock market (Hugues, 1986).
H1b. The level of detail in forecasts rises with the age of the firm undertaking
the IPO.
RAF As Lee et al. (2003) have shown, the firms that provide the most forecast disclosures in
6,2 their IPO prospectuses are those with the most highly qualified auditors (i.e. member of
a ‘‘Big Four’’ firm).
H1c. The level of detail in forecasts is positively associated with the firm’s auditor
belonging to a ‘‘Big Four’’ network.
138 The more capital the firm wants to raise, the more it will have to attract external
investors. In order to reduce information asymmetry, it is in management’s interest to
publish reliable forecasts, i.e. with a certain level of detail (Degeorge and Derrien, 2001).
H1d. The amount of the capital increase should be positively associated with the
level of detail in the forecasts.
If the retained ownership (percentage of shares retained by the original shareholders)
is low, then agency costs arise because potential investors may fear that the original
shareholders are selling low-prospect shares. As a consequence, a low retained

ownership rate should encourage management to publish earnings forecasts in order
to reduce these agency costs (Ruland et al., 1990). Studies based on signalling theory
show that a low retained ownership rate for an IPO can increase the use of other
signals such as earnings forecasts (Hugues, 1986). Both these theoretical fields
(agency and signalling theories) therefore generally suggest that publication of
forecasts is negatively associated with the rate of retained ownership by the original
shareholders.
H1e. The percentage of shares retained by the original shareholders (retained
ownership) is negatively associated with the level of detail in the forecasts.
Control variables: Firm size, IPO market, Industry sector and Year of IPO
The empirical evidence on the relationship between firm size and forecast disclosure is
variable. Cox (1985) and Lev and Penman (1990), in examining forecast disclosure by
listed firms, found a positive relationship; while Clarkson et al. (1991) and Mak (1996),
focusing on IPO firms, found no significant relationship between size and forecast
disclosure. In this study, firm size is included as a control variable in the determinants
tests. We also control for the IPO market, the industry sector of issuing firm and for the
year of IPO.
Profit forecast error after an IPO

In another stream of literature on forecast disclosures and IPOs, researchers have
sought to estimate the quality of forecasts by studying the errors in profit
forecasts. For IPO earnings forecasts to be credible and/or useful, they need to be
accurate. A body of empirical research has therefore emerged that examines the
accuracy of IPO earnings forecasts. After analysing determinants of the level of
detail in the forecasts contained in IPO prospectuses, we study the quality of the
forecasts, measured by the one-year ahead earnings forecast error. This study
complements the literature on the difference between forecast and actual earnings
following IPOs. Schatt and Roy (2002) assess the reliability of earnings forecasts
included in prospectuses in France. They show that the forecasts in the
prospectuses are more reliable than forecasts calculated using a time series model
and that young firms, which are generally in the new technologies sector, publish
less reliable forecasts than firms that are older or operate in other sectors.
Ownership retention by original shareholders appears to be an important factor: Disclosure in
the higher the retained ownership, the more accurate the forecasts.
Studies of earnings forecast error have also been carried out in New Zealand (Firth
IPO
and Smith 1992), Australia (Lee et al., 1993) and Canada (Pedwell et al., 1994; Jog and prospectuses
McConomy, 2003), where the errors were relatively significant compared to those
observed in Malaysia (Jelic et al., 1998), Singapore (Firth et al., 1995), and Hong Kong
(Chen et al., 2001)[4]. These articles used linear regression models to explain forecast
reliability. The following independent variables were studied: the firm size, growth,
139
forecast horizon, leverage, age, reputation of auditors, underwriters, issuers, and
market makers. Other than for the forecast horizon, the results on these independent
variables were mixed.
The link between the level of detail in forecasts and forecast error has apparently
never yet been tested. We assume that the level of detail in forecast disclosure is a
signal of reliability in the published earnings forecasts. By providing a detailed
framework for business forecasts, detailed information enables the manager to produce
better forecasts.
H2. The greater the detail in forecasts contained in the IPO prospectus, the lower
the forecast error.
In order to control for factors, other than the level of detail in earnings forecasts, that
influence forecast error, six variables are introduced: initial forecast error, proportion of
shares retained by the owners, amount of capital increase, firm age, firm size, and
leverage. We discuss the rationale for introducing these variables.
The greater the forecast error at the time of the IPO, the greater the error will be in
the future. In this study we examine the forecast error the year following the IPO. We
assume that forecast error is a self-cumulative phenomenon, i.e. the greater the forecast
error the year of the IPO, the greater the error the following year.
Control variable 1: The forecast error will be positively associated with the forecast
error at the date of the IPO. The pre-IPO shareholders are more sensitive to market
sanctions in the event of inaccurate forecasts, and this encourages them to devote
more resources to establishing reliable profit forecasts. This argument is consistent
with the signalling role for retained ownership suggested by Leland and Pyle
(1977).
Control variable 2: The forecast error will be lower for firms whose original
shareholders retain a higher proportion of shares. The future cash flow generated by
new projects financed by capital raised by the IPO is more difficult to estimate
accurately (Degeorge and Derrien, 2001).
Control variable 3: The forecast error will grow with the amount of capital increase.
The oldest firms have better control over their market, and their market forecasts are
easier to establish. The profits of companies with a short or no prior operating history
are likely to be more difficult to forecast, given the fact that historical data are very
important inputs to the process of a forecast (Jelic et al., 1998). Even if a new company
were to rely on the operating history of other companies in the same or a related
industry, the available information on the operating history of those companies is
likely to be a less reliable predictor of future earnings than one’s own operating history
(Mak, 1994). Jaggi (1997), examining a sample of 161 IPOs on Hong Kong, found that
older companies were associated with smaller errors.
Control variable 4: The forecast will be lower as firm age rises. Large companies are
likely to have more influence over their market environment, as well as having more
RAF control over the level of their profits, i.e. over earnings volatility. Large firms also tend
6,2 to be more diversified, both geographically and in terms of their business. This could
be another reason why volatility may be low. Firth and Smith (1992) found that
company size had an unanticipated positive relationship with forecast errors, and Chen
et al. (2001) showed that size is negatively related to the error measures. Nevertheless,
Jelic et al. (1998) found that size is negatively but not significantly related to forecast
140 error. Firm size is therefore included in this study as a control variable in the forecast
error model, anticipating a negative sign.
Control variable 5: Firm size and forecast error are negatively related. Previous
empirical results on leverage are inconclusive. Chen et al. (2001), in Hong Kong, and
Jelic et al. (1998), from Malaysia, found no significant relationship between the leverage
of the company and forecast error. But profits of companies with high leverage are
traditionally regarded as being more volatile and thus more difficult to forecast (Firth
and Smith, 1992; Mohamad et al., 1994).
Control variable 6: Leverage and forecast errors are positively related. We

also control for the industry sector of issuing firm, the IPO market and for the year
of IPO.
4. Sample and methodology

This section describes how the sample was developed and the methodology used.
Sample
Our sample includes 89 IPOs on the Euronext Paris Nouveau marché and Second
marché between January 01, 2000 and December 31, 2002. We did not include
premier marché IPOs as the firms on that market were too different. Since IPOs
on the premier marché concern either much larger firms than those floating on
the Second marché and Nouveau marché, or partial privatisations of nationalised
firms, the firms involved are not comparable with our sample firms[5]. Of the
118 IPOs that took place over the period on the markets studied, we selected the
89 with prospectuses available in PDF format (on the AMF website) or on paper
(from the AMF documentation center), which represents 75 per cent of the total
IPOs of 2000, 2001, and 2002. All information on features of the issue, the firm
(other than its financial statements), and forecasts is taken from these IPO
prospectuses. It was first collected manually, then coded by another researcher
for ten prospectuses to ensure coherence. Both codings generated identical results.
The information concerning the financial and accounting aspects of the firms for
the year of their IPO and the following years is taken from the DIANE database,
which contains data for both listed and unlisted firms. This meant we could
obtain financial statements for the year of the IPO. Of the 89 firms, the DIANE
database only contained information (consolidated financial statements before and
after the IPO) for 82 firms, i.e. 69 per cent of the initial population.
Table II presents the financial information for sample firms. Their features are
consistent with the market chosen. The Second marché attracts older firms, with
higher leverage than those traded on the Nouveau marché. High-tech firms with major
financing requirements tend to choose the Nouveau marché. The firms on this market
are also more often audited by the big four firms. This may be due to the fact that firms
undertaking IPOs on the Nouveau marché are often little-known, and want to confer
credibility on their financial communication by engaging well-known auditors.
Total Nouveau Second Disclosure in
sample marché marché Tests IPO
Variable Definition Mean Med. Mean Med. Mean Med. Mean Med.
prospectuses
AGE Ln(age) 2.04 2.20 1.85 1.79 2.38 2.52 0.09* 0.04**
LEV Leverage ratio 0.12 0.06 0.06 0.01 0.22 0.19 0.00*** 0.00***
HT High-tech firms (0,1) 0.22 0.00 0.33 0.00 0.03 0.00 0.00*** 0.00***
INCCAP Ln(Capital increase) 0.70 0.54 0.93 0.60 0.33 0.29 0.06* 0.00*** 141
B4 Auditor B4 (0,1) 0.55 1.00 0.65 1.00 0.38 0.00 0.01*** 0.00***
SIZE Ln(Total assets) 10.51 10.39 10.44 10.38 10.61 10.57 0.37 0.93
RET Retained ownership (%) 0.74 0.76 0.75 0.78 0.73 0.71 0.38 0.08*
HORIZ Forecast horizon 2.52 3.00 2.61 3.00 2.34 3.00 0.31 0.33
Notes: *Significant at 10 per cent, **significant at 5 per cent, ***significant at 1 per cent.
Significance levels are two-tailed. The last two columns report the p-levels of tests of equality of Table II.
means and medians between the Nouveau marché and the Second marché for each variable
Sample characteristics
However, firm size, the forecast horizon and the rate of retained ownership are similar
on the two markets.
Measurement of disclosure level

The following procedure was applied to measure the quantity of forecast information
published. Starting from an initial score of zero, each firm’s score rises if it publishes
forecasts. Five factors were taken into consideration:
(1) Publication of a (simplified) forecast balance sheet: one point if one is
published, zero otherwise.
(2) Publication of a forecast income statement confers a score of between zero
and two: zero if no income statement is published, one point if a simplified
income statement is published, two points if a detailed income statement is
published.
(3) Publication of a cash flow statement: one point if one is published, zero
otherwise.
(4) If a table of key figures is included, the firm scores an extra point.
(5) If details of assumptions are provided, the firm scores an extra point.
As seen in Panel A, Table III, 28 per cent of firms publish a forecast balance sheet, 51
per cent a cash flow statement, 83 per cent a table of key indicators and the same
proportion disclose details of the assumptions used in a specific section. Concerning
publication of a forecast income statement (data not tabulated), analysis shows that 18
per cent of firms do not publish one, 43 per cent publish one in the form of ‘‘key
figures’’, and 39 per cent publish a detailed income statement. There is no significant
difference in the amount of disclosure between the Second marché and Nouveau
marché.
Based on these data on disclosure or non-disclosure and their justification, three
indicators of disclosure quantity can be constructed:
. Score 1 is the sum of scores for each of the five items. A firm that discloses no
forecasts would score zero, and the maximum possible score of six would
RAF Tests of
6,2 Equality Equality of
Standard of means medians
Variable Mean deviation Median (t-tests) (Mann–Witney test)
Panel A: Presence of forecast elements

Balance sheet (0 or 1) 0.28 0.45 0 0.6316 0.6289
142 Income statement (0, 1 or 2) 1.21 0.73 1 0.726 0.8788
Cash flow statement (0 or 1) 0.51 0.5 1 0.9376 0.937
Key indicators table (0 or 1) 0.83 0.38 1 0.4168 0.4136
Section on assumptions (0 or 1) 0.83 0.38 1 0.1615 0.1602
Panel B: Scoring of forecast information
Score 1 (= sum of items) 3.66 1.86 4 0.6552 0.8893
Score 2 (= dummy variable) 0.61 0.49 1 0.7945 0.7928
Score 3 (= factor analysis) 0 1 0.35 0.4509 0.8739
Panel C: Scoring convergence

Table III. Score 1 Score 2 Score 3
Forecast disclosure Score 1 (= sum of items) 1
indexes and test of Score 2 (= dummy variable) 0.9721*** 1
equality by issuing Score 3 (= factor analysis) 0.7055*** 0.7317*** 1
market (Second Marché
vs Nouveau Marché) Notes: *Significant at 10 per cent, **significant at 5 per cent, ***significant at 1 per cent
correspond to a firm whose prospectus includes a detailed income statement, a

balance sheet, a cash flow statement, key indicators and a section on
assumptions.
. Score 2 is a binary variable coded 1 if the Score 1 score is higher than three. This
is designed to discriminate between firms publishing little information (Score 1
score under three) and firms publishing a lot of information (Score 1 score of
three or more). The main justification for using Score 2 is that the statistical
distribution of Score 1 is strongly bi-modal. In other words, either firms disclose
a considerable amount of information (Score 2 = 1), or they publish very little
information (Score 2 = 0).
. Score 3 is the score resulting from factorial analysis of the five disclosure items
(balance sheet, income statement, cash flow statement, key indicators, section on
assumptions).
Panel B, Table III shows that Score 1 varies from one to six, with an average of 3.66
(median 4). The mean value of Score 2 is 0.61: 61 per cent of firms can be considered
to disclose a considerable amount of information (Score 2 = 1), and this
overrepresentation of firms disclosing much information is confirmed by analysis of
Score 3. The median for Score 3 (0.35) is higher than the mean (which by
construction is zero). Analysis of the disclosure quantity is relatively insensitive to
the method used to aggregate items. The correlation coefficients between the three
measures are very high and significant at 1 per cent, as indicated in panel C, Table
III. The rest of this paper uses Score 2. The rationale for choosing Score 2 as the
measure of forecast disclosures is that the information disclosed is binary in nature:
either the firms chose to publish detailed forecasts or very brief forecasts, with
almost no justification.
5. Empirical results Disclosure in
Research design
The first stage studies the determinants of forecast disclosure in IPO prospectuses. As
IPO
the variable studied (Score 2) is binary, a logit regression is used. Next, the influence of prospectuses
forecast disclosure quantity on earnings forecast error is examined. Our hypothesis is
that the more disclosures a firm makes, the lower the earnings forecast error
(difference between the reported earnings and expected earnings scaled by total assets) 143
will be.
To assess the determinants of voluntary disclosure, we use the following model
(logit regression):
Score 2 ¼ 0 þ 1 HORIZ þ 2 AGE þ 3 B4 þ 4 INCCAP þ 5 RET
X
þ 6 SIZE þ 7 NM þ 8 HT þ 9;k YEARk þ "i;t ð1Þ
k
where, HORIZ is the forecast horizon, measured by the number of forecast years; AGE
is the firm’s age, measured by: Ln (age in years); B4, Audit quality, is a dummy variable
coded 1 if one auditor at least is from: Arthur Andersen[6], PriceWaterhouseCoopers,
Ernst and Young, Deloitte or KPMG; INCCAP is the capital increase measured by: Ln
(collected funds in )/lagged Total assets; RET is the retained ownership, measured by:
(number of shares after the IPO – number of shares issued – number of shares sold)/
(number of shares after the IPO); SIZE is the firm’s size, measured by Ln(Total net
assets); NM, Nouveau marché, is a dummy variable coded 1 if the firm’s IPO is on the
Nouveau marché; 0 otherwise; HT, High-tech industry, is a dummy variable coded 1 if
the firm belongs to software, communication, phone, bio-tech industries; 0 otherwise;
YEAR is a control variable for year of IPO.
The first five variables are used in the test of hypotheses H1a to H1e. Size, IPO
market, industry sector (high-tech or other) and the year of the IPO are introduced as
control variables.
The model of forecast error is as follows:
ErrorðN þ 1Þ ¼ 0 þ 1 Score 2 þ 2 ErrorðN Þ þ 3 RET þ 4 INCCAP þ 5 AGE
þ 6 SIZE þ 7 LEV þ 8 HT þ 9 NM þ 10 YEAR þ "i ð2Þ
where, Score 2 is the level of voluntary disclosure, a dummy variable (0/1); Error(N) is
the forecast error in year N, measured by: (Published income in N – forecast income in
N)/Total assets; RET is the retained ownership, measured by: (number of shares after
the IPO – number of shares issued – number of shares sold)/(number of shares after the
IPO); INCCAP is the capital increase measured by: Ln (collected funds in )/lagged Total
assets; AGE is the firm’s age, measured by: Ln (age in years); SIZE is the firm’s size,
measured by Ln(Total net assets); LEV is a leverage ratio measured by the ratio of
liabilities on total assets; HT, High-tech industry, is a dummy variable coded 1 if the
firm belongs to software, communication, phone, bio-tech industries; 0 otherwise; NM,
Nouveau marché, is a dummy variable coded 1 if the firm’s IPO is on the Nouveau
marché; 0 otherwise; YEAR is a control variable for year of IPO; The coefficient of
interest is 1. Initial forecast error, retained ownership, firm age, capital increase, size,
leverage, industry sector (high-tech or other), IPO market and year of IPO are
introduced as control variables.
RAF Regression results
6,2 Table IV presents the empirical results of the determinants study. Overall, the model
proposed explains 42 per cent of the variance (Cragg and Uhler’s R2). Only two
variables emerge as significant: forecast horizon and firm age. The longer the firm’s
forecast horizon, the more detailed the information provided, which conforms to our
hypothesis H1a. The older the firm (i.e. the longer it has existed), the more detailed its
144 disclosures (H2a). The other variables are not significant. Collinearity diagnosis
(calculation of VIF) does not indicate any significant problem (average VIF is 1.60, with
maximum VIF of 2.09).
Table V presents empirical results on forecast error. The adjusted R2 is 32 per cent.
We test two specifications of the model. All models are free of collinearity problems
because the average VIF of the variables is 1.54, and no individual VIF is higher than
1.94. Qualitatively, the results are identical for both regressions.
Model 1 is the base model. Four variables are significant at 10 per cent:
(1) The coefficient for the Score 2 variable is negative and significant. There are
two non-exclusive interpretations for this finding. The first suggests that
detailed disclosures reduce forecast error (hypothesis H2): by providing a
detailed framework for business forecasting, detailed information enables the
manager to produce better forecasts. This result may also reveal a self-selection
bias: it is possible that only firms with reliable forecasts disclose detailed
information. We will discuss this issue below. Note however, that although the
level of detail can be known as soon as the year of the flotation, the forecast
error is known only one year after the IPO. This means that the level of detail
signals positive future prospects.
(2) The forecast error for the previous year: the coefficient is positive, which
suggests that forecast errors do not balance out from one year to the next.
Statistically, this coefficient is not different from one, which means a forecast
error in the initial year ‘‘carries over’’ from one year to the next.
Predicted sign b t p
HORIZ + (H1a) 1.430 (3.788) 0.000

AGE + (H1b) 0.881 (2.323) 0.020
B4 + (H1c) 0.385 (0.535) 0.593
INCCAP + (H1d) 1.759 (1.391) 0.164
RET + (H1e) 2.645 (1.074) 0.283
SIZE ? 0.539 (1.057) 0.291
NM ? 0.420 (0.511) 0.610
HT ? 0.340 (0.450) 0.653
YEAR 2000 ? 0.732 (0.903) 0.366
YEAR 2002 ? 0.602 (0.431) 0.666
Constant 13.014 (1.866) 0.062
Chi2 33.994
p(chi2) 0
Number of observations 82
Table IV. Gragg and Uhler’s R2 0.42
Determinants of forecast
disclosure Note: See equation (1)
Model 1 Model 2 Disclosure in
Predicted sign b t p b t p IPO
prospectuses
Score 2 (H2) 0.467 (2.442) 0.018 0.494 (2.436) 0.019
Error N + (PL) 0.833 (4.671) 0.000 0.879 (4.838) 0.000
RET (PL) 2.609 (1.930) 0.059 2.621 (1.909) 0.062
INCCAP + (PL) 0.108 (3.127) 0.003 0.110 (3.293) 0.002
AGE (PL) 0.088 (0.803) 0.426 0.047 (0.489) 0.627 145
SIZE (PL) 0.164 (1.561) 0.125 0.175 (1.705) 0.095
LEV + (PL) 0.426 (0.597) 0.553 0.517 (0.774) 0.443
HT ? 0.304 (1.325) 0.191 0.312 (1.348) 0.184
NM ? 0.425 (1.476) 0.146 0.391 (1.263) 0.213
YEAR 2000 ? 0.678 (2.196) 0.033 0.695 (2.205) 0.032
YEAR 2002 ? 0.085 (0.455) 0.651 0.026 (0.139) 0.890
IMR 1.013 (0.853) 0.398
Constant 3.566 (1.885) 0.065 3.719 (1.984) 0.053
R2 0.359 0.367
Number of observations 82 82
Table V.
Notes: See equation (2). PL, from previous literature Forecast error
(3) The retained ownership percentage (pre-IPO shareholders) influences the

forecast error. The more old shareholders ‘‘remain’’, the lower the forecast error
(hypothesis H2c). This result is consistent with agency theory: if the ‘‘historical’’
shareholders are leaving the firm at the time of the IPO, it is in their interest to
publish optimistic forecasts to push the new share price up.
(4) Forecast error grows with the amount of funds raised, suggesting that the
larger the new projects financed by the IPO, the more difficult it will be to
predict cash flows generated by these projects.
The other variables are not significant.
As outlined above, interpretation of 1 is not straightforward. The negative
association between the level of detail in forecast information and forecast errors may
either be evidence that detailed information leads to less forecast error, or alternatively
it may indicate the existence of a selection bias (only firms with reliable forecasts
disclose detailed forecasts). Equation (2) is potentially mis-specified, if firms potentially
self-select to disclose detailed or basic earnings forecasts based on factors that are
associated with the relationship between current forecast error (i.e. Error(N) the year of
the IPO) and future earnings forecast (Error(N+1), the year following the IPO year). In
particular, in Table IV we show that detailed forecasters are older and forecast over a
longer horizon than ‘‘basic’’ forecasters. Since these factors potentially create
endogeneity in the equation (2), we re-estimate the model controlling for endogeneity
by using the method proposed by Chaney et al. (2004) and by Ball and Shivakumar
(2005). Both papers consider the situation where a grouping variable (in our case Score
2) is endogeneous. We therefore estimate the model using the two-stage approach of
Heckman (1979) and Lee (1979). In the first stage, we estimate the ‘‘level of detail’’
choice equation as a probit model and, using the parameters from this model, we
compute the inverse Mills ratio for all firms. In the second stage, we estimate the future
RAF earnings forecast error, including the inverse Mills ratio as an additional control. The
inclusion of this variable acts as a control for endogeneity of Score 2.
6,2 The first stage therefore consists of a probit model, explaining the ‘‘level of detail’’
choice as a function of firm age and the forecast horizon (the two variables that appear
as significant in Table IV). The second stage is equation (2) augmented with the Inverse
Mills Ratio (IMR). Concentrating on the variable of interest (Score 2), we find no change
either in the magnitude (0.513 vs 0.476) or the significance level (p = 0.019, p = 0.017)
146 of the coefficient. The inverse Mills Ratio is not significant (p = 0.0175). Taken together,
these findings suggest that our results are not driven by self-selection.
6. Conclusion
This study examines the relationship between the level of detail in forecast disclosures
and the reliability of the earnings forecasts in the high information asymmetry
environment of IPOs. We have successively studied two issues raised by forecast
disclosures in IPO prospectuses: what are the determinants of the level of detail in
forecast disclosures? And: what is the impact of the level of detail on the earnings
forecast error?
Our results on the determinants of forecast disclosure indicate that only firm age
and forecast horizon present any positive, significant association with our measure of
the level of detail in forecast disclosures contained in IPO prospectuses. These findings
are in accordance with results from New Zealand, an environment where litigation
risks are moderate (Mak, 1996). Four variables explain the earnings forecast error:
publication of detailed forecast disclosures and the rate of retained ownership by
original shareholders reduced forecast error, whereas it rises as the capital raised and
the initial forecast error increase. Two conflicting interpretations exist for the negative
relationship between ‘‘detailed’’ forecast disclosures and forecast error. First, this
negative relationship may mean that disclosing detailed forecasts leads to less forecast
error because forecasts are more reliable. On the other hand, it may indicate that only
firms with reliable forecasts publish ‘‘detailed’’ forecasts (self-selection bias). Our
robustness check suggests that the former interpretation is appropriate.
This paper contributes to the literature in two ways. First, we present evidence that
the way forecast information is disclosed in IPO prospectuses is of importance. This
represents a shift compared to past empirical literature that focuses on the presence or
absence of forecast disclosure. Second, we document a negative association between
forecast error and the level of detail in forecast disclosures. This hypothesis test is
entirely new and shows that disclosure of detailed forecast information could lead to a
smaller forecast error or signal companies with reliable forecasts. This result reinforces
the role of financial disclosures as a means to reduce information asymmetry. This
research could have implications for stock market regulators, as it suggests that
mandatory disclosure of highly detailed forecasts would improve the efficiency of the
markets by reducing forecast error.
The paper suffers from at least two potential flaws. First, omitted variables, such as
the possession of good news or proprietary costs, can influence both forecast errors
and the level of detail of forecasts. However, the measurement of such variables is
difficult and their inclusion in our regressions might have raised new issues (e.g.
measurement error in independent variables, colinearity, etc.). Second, the negative
association between the level of detail in forecast information and forecast errors may
either show that detailed information leads to less forecast error or reflect a self-
selection bias (only firms with reliable forecasts disclose detailed forecasts). In this
paper we have preferred the causality view, but despite our robustness check the self- Disclosure in
selection bias explanation cannot be completely ruled out. IPO
These limitations could provide the basis for future research, examining the links
between earnings management and the level of detail in forecast information can be prospectuses
studied, or the influence of the management over-optimism bias on the disclosure of
detailed forecasts (Eliott et al., 1995).
147
Notes
1. Euronext is the pan-European stock market common to Paris, Amsterdam, Lisbon and
Brussels.
2. Translated extract from the AMF’s Instruction of December 2001 in application of COB
regulation 95-01. In 2003, the COB (Commission des Opérations de Bourse) merged with
the CMF (Conseil des Marchés Financiers) to become the AMF (Autorité des Marches
Financiers).
3. Although the regulatory body requires forecasts to be disclosed on the Nouveau marché,
it does not specify the form of that forecast and the level of detail contained.
Consequently, detailed forecast disclosure on the Nouveau marché could be considered a
form of voluntary disclosure.
4. Forecast disclosure is allowed in Australia, NewZealand and Hong Kong, and
mandatory in Malaysia and Singapore.
5. 25 firms undertook an IPO on the premier marché in 2000, 2001 and 2002: seven are
formerly state-owned firms that were privatized, 18 are large firms prevously privately
owned either by individuals (e.g. JC Decaux) or by investment funds (e.g. Générale de
Santé).
6. In France, Arthur Andersen merged with Ernst and Young in 2002.
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Corresponding author
Anne Cazavan-Jeny can be contacted at: cazavan@essec.fr
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Levels of Voluntary Disclosure in IPO Prospectuses

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Levels of Voluntary Disclosure in IPO Prospectuses

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Review of Accounting and Finance

Levels of voluntary disclosure in IPO prospectuses: an empirical analysis

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Levels of voluntary disclosure in Disclosure in

Forecast disclosures in IPO prospectuses

in the IPO’s under French rules, three certified financial

Publication of forecasts at the Time of IPOs

differentiate their IPO from those of lower quality firms.

shareholders are selling low-prospect shares. As a consequence, a low retained

Profit forecast error after an IPO

Control variable 6: Leverage and forecast errors are positively related. We

4. Sample and methodology

Measurement of disclosure level

Panel A: Presence of forecast elements

Panel C: Scoring convergence

correspond to a firm whose prospectus includes a detailed income statement, a

HORIZ + (H1a) 1.430 (3.788) 0.000

(3) The retained ownership percentage (pre-IPO shareholders) influences the

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